The "Size Premium" in Equity Markets: Where is the Risk?

TL;DR

This paper demonstrates that the size effect in equity markets persists when measured by dollar-turnover and neutralized for beta and low-volatility, showing it is a significant factor comparable to well-known market anomalies.

Contribution

It reveals that the size premium remains significant in dollar-turnover terms and is less correlated with other anomalies, challenging traditional risk-based explanations.

Findings

Size effect persists in dollar-turnover measures.

CMH anomaly has a long-term t-stat of 5.1.

Size portfolios are nearly unskewed, with large caps dominating extreme risks.

Abstract

We find that when measured in terms of dollar-turnover, and once $\beta$-neutralised and Low-Vol neutralised, the Size Effect is alive and well. With a long term t-stat of $5.1$, the "Cold-Minus-Hot" (CMH) anomaly is certainly not less significant than other well-known factors such as Value or Quality. As compared to market-cap based SMB, CMH portfolios are much less anti-correlated to the Low-Vol anomaly. In contrast with standard risk premia, size-based portfolios are found to be virtually unskewed. In fact, the extreme risk of these portfolios is dominated by the large cap leg; small caps actually have a positive (rather than negative) skewness. The only argument that favours a risk premium interpretation at the individual stock level is that the extreme drawdowns are more frequent for small cap/turnover stocks, even after accounting for volatility. This idiosyncratic risk is however clearly diversifiable.